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Some Early Tax Planning for 2010
By Dave Hovey
If you are one of those tortured souls that has never been able to roll over retirement funds to a Roth IRA (a “Roth”), then you may finally be in luck because in 2010, more taxpayers will be allowed to convert qualified retirement funds into a Roth. Previously, only taxpayers with modified adjusted gross income (“MAGI”) of $100,000 or less were allowed to roll-over such amounts to a Roth IRA and married persons filing separately were not able to make such rollovers at all. You can now roll over certain amounts in qualified employer sponsored retirement plan accounts such as 401(k) s and profit sharing plans, as well as regular IRAs, into Roth’s, regardless of your MAGI. What's so attractive about a Roth? Here's a summary:
- Earnings within the account are tax-sheltered (as they are with a regular qualified employer plan or IRA).
- Unlike a regular qualified employer plan or IRA, withdrawals from a Roth aren't taxed if some relatively liberal conditions are satisfied.
- A Roth owner does not have to commence lifetime required minimum distributions (“RMDs”) after he or she reaches age 70 1/2 as is generally the case with regular qualified employer plans or IRAs (in 2009 there was a moratorium on RMDs.)
- Beneficiaries of Roths also enjoy tax-sheltered earnings (as with a regular qualified employer plan or IRA) and tax-free withdrawals (unlike a regular qualified employer plan or IRA.) They do, however, have to commence regular withdrawals from a Roth after the account owner dies.
Sounds great right? Well the catch, and it's a big one, is that the rollover, will be fully taxed, assuming it is being made with pre-tax dollars (i.e. money that (i) was deductible when contributed to an IRA, or (ii) wasn't taxed to an employee when contributed to a qualified employer sponsored retirement plan, or (iii) was the earnings on those pre-tax dollars, assuming you are one of those few that has any earnings left on your investments.)
For example, if you are in the 28% federal tax bracket and roll over $100,000 from a regular IRA funded entirely with deductible dollars to a Roth, you'll owe $28,000 of tax (or possibly more if the rollover amount pushes you to a higher tax bracket). So you'll be paying tax now for the future privilege of tax-free withdrawals, and freedom from the RMD rules.
Taking advantage of this new opportunity won’t be for everyone, but it might be right for you if:
- You can pay the tax hit on the rollover with non-retirement-plan funds. Keep in mind that if you use retirement plan funds to pay the tax on the rollover, you'll have less money building up tax-free within the account, and you might get stuck with a 10% penalty for not rolling over the entire amount.
- You anticipate paying taxes at a higher tax rate in the future than you are paying now. Many observers believe that tax rates for upper middle income and high income individuals will trend higher in future years.
- You have a number of years to go before you retire and need the cash from the IRA. This will give you a chance to recoup (via tax-deferred earnings and potentially tax-free payouts) the tax hit you absorb on the rollover. In other words, the future potentially tax-free withdrawals can more than offset the tax paid up front.
- You are willing to pay a tax price now for the opportunity to pass on a source of tax-free income to your beneficiaries.
Notwithstanding the above tax ramifications, if you make this change in 2010, the resulting taxable income, and the tax that you'll owe as a result of the rollover, can be spread over 2010 and 2011! Of course, you are always able to elect to pay the entire tax bill in 2010.
Why on earth would you choose to pay a tax bill in 2010 instead of deferring it to 2011 and 2012? Keep in mind that absent Congressional action, after 2010 the tax brackets above the 15% bracket will revert to their higher pre-2001 levels. That means the top four brackets will be 39.6%, 36%, 31%, and 28%, instead of the current top four brackets of 35%, 33%, 28%, and 25%. The Administration has proposed to increase taxes only for those making $250,000 or more, but it is difficult to predict who will actually get hit by higher rates. So if you believe there's a strong chance your tax rates will go up after 2010, you may want to consider paying the tax on the Roth rollover entirely in 2010.
As always, before you plan for a potential large rollover to a Roth in 2010, you should discuss your family's entire financial situation with a qualified advisor. There are many details that should be discussed before making the decision, such as whether the amounts you are thinking of switching to a Roth are eligible for the rollover (technically, they are called “eligible rollover distributions”), whether you can make rollovers from your employer sponsored plan (there are certain restrictions), and the tax impact of rolling over amounts that represent nondeductible, as well as deductible, contributions.
About the Author
David Hovey is a Sr. Tax Manager with Kingery & Crouse PA in Tampa, FL. Dave, an international tax expert, joined the firm in August, 2009 offering 17+ years of experience building, leading, and advising professional staff through complex international structuring, restructuring, acquisition, sales, and related compliance for multi-national entities. Kingery & Crouse PA is a full service public accounting firm offering audits of private and public companies, tax planning & research, employee benefit plan audits and many other accounting services. You may contact Dave @ (813) 874-1280 ext 201 or find us on the web at www.tampacpa.com
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